Money on the Table

Posted: April 29, 2008

Global import and export merchandise trade is valued at nearly $12 trillion, according to the World Trade Organization, some 75 times larger than in the mid-1960s. Yet despite this huge growth, most companies still use the same trading contract terms and structure that were prevalent decades ago. As a result, importers are missing a major opportunity to improve their reported financial results by failing to take full advantage of a little-known aspect of Incoterms 2000, the internationally accepted standard definitions of trade terms. Even major global trading companies do not realize how much flexibility they have to determine how and when the title to goods they import will transfer. Importers can structure contracts of sale to use Incoterms.

Defining Incoterms

Incoterms (International Commercial Terms) were developed by the Paris-based International Chamber of Commerce in the 1930s, and have been regularly revised to reflect changes in transportation and documentation. They specify the exporting seller’s and importing buyer’s obligations regarding carriage, risks and costs, and establish basic terms of transport and delivery. Incoterms do not define contractual rights other than for delivery, and both parties must specify the delivery terms as well as other issues, such as loss insurance and title transfer (a fact often misunderstood when contracts are negotiated).

Newer and smaller importers generally specify Group C Incoterms (including CIF) in which the seller arranges and pays for the main carriage without assuming its risk, another fact often overlooked by importers. They do so believing that it’s more convenient for the seller to handle these details, but generally wind up paying a higher price because the seller builds inflated shipping costs into their landed price. The importer is then further frustrated having to deal with a freight company chosen by the seller and who does not represent their best interests. Sophisticated importers prefer to use Group F terms (such as FOB, or “Free on Board”), giving them greater control over their shipments, and because risk and cost transfer from the seller to the buyer in any case (as with CIF), they are still able to manage and control their freight destiny.

When Does Ownership Transfer?

Increased supply chain visibility and the control of import shipments are critical FOB benefits. By taking control as cargo crosses the ship’s rail at the port of origin, importers are better able to obtain accurate and timely shipment information through working with the third party logistics provider of their choosing. Moreover, Incoterms do not deal with the transfer of ownership, when transfer of title in goods takes place, or other considerations necessary for a complete contract of sale. The issue of the transfer of title remains subject to what has been separately agreed upon between the parties in the relevant contract of sale and applicable law.

Importers who take the initiative—and have the market clout—can thus specify in their contract that title to the goods does not transfer from the seller until the importer takes possession at the port of entry or at a later point that they specify, even though the importer is paying the cost of freight. By deferring actual ownership until this future date, importers can delay accounting for costly shipments as inventory on their financial statements, thus lowering expenses and boosting reported income. The sales contract can provide for supplier invoicing upon confirmed arrival at destination port, and tracking will be made available to the supplier on-line and via e-mail notification. An online tracking system, which can give visibility to both the seller and buyer as well as allow for real time cross-checking and timing of shipments, is a huge advantage in making such arrangements work.